Reasons to remain positive on China’s banking sector
• Valuations look compelling for China’s banks
• Regulation and reform should be positives for the sector
• Bank of China is one of the fund’s largest holdings
Whilst concerns about asset quality have continued to plague the Chinese banking sector, we have taken the view that the market has already priced in a significant deterioration in returns on equity.
Valuations at this point are extremely compelling for China’s banking sector, which trades on a price to book ratio of 0.9 times based on 2014 estimates, has a price earnings multiple of around five times for 2014 and a dividend yield of 6%. Meanwhile, the estimated return on equity for next year is 18%. With Bank of China one of the largest holdings in the fund (3.1%)*, we remain positive about the prospects for this sector.
Despite recent strong performance, there are widespread doubts about the historically fast pace of loan growth and the associated asset-quality issues this could bring. This may be exacerbated by slowing loan growth impacting profitability for the sector. However, there is a fundamental shift occurring in the Chinese economy, with a number of outstanding issues in the sector still to be settled. The Central Committee’s November meeting should shed some light into potential regulation for the sector. Whilst some of the moves in interest rate liberalisation may cause some short-term weakness, the fundamental issues of local government debt and ‘shadow banking’ should be addressed.
There is, for example, talk of draft measures pointing towards a significant relaxation of bank liquidity rules, with the possibility that loan-to-deposit (LDR) regulation may ease. In addition, we should hear more from the National Audit Office on the scale of local government debt. This could pre-empt a shift of expenditure responsibility for areas such as education, social security and healthcare, which currently originate at the local level, back to central government. This should, in turn, reduce market concerns over local governments’ ability to finance their debt obligations. Improving transparency and risk management surrounding the ‘shadow banking’ sector would also be a positive.
In summary, operating performance has been promising and we believe the third quarter results season has provided a timely reminder of the Chinese banking sector’s good health. There are a number of positive regulatory events that could help shape an orderly transition to sustainable growth for the world’s second-largest economy and importantly its banking sector. We take confidence from recent improvements in macroeconomic data releases; the Chinese government’s strong balance sheet and an expectation that key reforms to fiscal, financial and land policies are on the horizon.
Mike Kerley, manager of the Henderson Asian Dividend Income Unit Trist and the Henderson Horizon Asian Dividend Income Fund
*Source Henderson Global Investors at 31 October 2013
